Sept 09, qu7.

[marmalade]

In the solutions, it mentions about there being two assumptions for investment return on EV basis: one to project assets and a risk disc rate to discount future profits. However it says that there is no equivalent parameter to the risk discount rate for a reserving basis. I don't understand this. Is it because reserving basis uses prudent assumptions and so no future profit expected?

I think I'm confused! What discount rate is used to discount the liability cashflows in order to determine the PV?
Also why are assets not taken at market value? Why are they projected? Surely if they are projected then they will also have to be discounted to get todays value?

Thanks in advance.

 

[Muppet]

A risk discount rate is used to discount expected future profits (projecting all the future positive and negative cashflows, including the positives from our assets). So you would use an RDR when pricing (profit-testing like in CT5) or calculating EVs.

A reserving basis/calculation is used to determine the PV of future liabilities (claims and expenses, allowing for future premiums). If using a discounting approach, we're discounting using an investment return/interest rate assumption - usually called the valuation interest rate. Some might say this is similar to a RDR with a different name - but they are subtly different.

Part of your embedded value is the PV of future expected profits (the other part is the net assets). So inside this calculation you need to project forward the assets backing your liabilities to determine the profits you expect to make at the end of each year, say. We need an investment return assumption to do this. We then discount the profits at the RDR. The two rates may or may not be the same depending on the basis being used (eg market consistent).